3M Company (MMM) — Q2 2021 Earnings Call Transcript

Thank you, and good morning, everyone, and welcome to our second quarter earnings conference call. With me today are Mike Roman, 3M's Chairman and Chief Executive Officer; and Monish Patolawala, our Chief Financial Officer. Mike and Monish will make some formal comments, then we will take your questions. Please note that today's earnings release and slide presentation accompanying this call are posted on our Investor Relations website at 3m.com under the heading Quarterly Earnings. Please turn to Slide 2. As we have done throughout the year, I would like to remind you to mark your calendars for our next earnings call, which will take place on Tuesday, October 26. Please take a moment to read the forward-looking statement on Slide 3. During today's conference call, we will make certain predictive statements that reflect our current views about 3M's future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-K lists some of the most important risk factors that could cause actual results to differ from our predictions. Please note, throughout today's presentation, we'll be making references to certain non-GAAP financial measures. Reconciliations of the non-GAAP measures can be found in the attachments to today's press release. Please turn to Slide 4, and I'll now hand it off to Mike.

Thank you, Bruce, and good morning, everyone. 3M's performance in the second quarter was strong as we posted organic growth across all business groups and geographic areas. Our team executed well and delivered increased earnings, expanded margins and robust cash flow. From a macro perspective, the global economy continues to improve, though uncertainty remains due to COVID-19 and heightened concern over the increase in Delta variant cases. We saw ongoing strength in many end markets, including home improvement, oral care and general industrial, along with a pickup in health care elective procedures. We continue to work to mitigate ongoing inflationary pressures and supply chain challenges as well as end market dynamics such as the semiconductor shortage impacting automotive build rates and electronics. We are also beginning to see a decline in pandemic-related demand for disposable respirators, which I will discuss on the next slide. Looking forward, we will stay focused on investing in emerging growth opportunities, improving productivity and advancing sustainability. We are confident in our ability to continue executing well in the face of COVID-19 uncertainties and are raising our full year guidance for organic growth to 6% to 9%, and earnings per share to $9.70 to $10.10. Please turn to Slide 5. In the second quarter, we delivered total sales of $8.9 billion. We posted organic growth of 21% versus a 13% decline in last year's second quarter, along with earnings of $2.59 per share. We expanded adjusted EBITDA margins to over 27% and increased adjusted free cash flow to $1.6 billion with a conversion rate of 103%. Strong cash flow allowed us to further strengthen our balance sheet while returning $1.4 billion to shareholders through dividends and share repurchases. I am proud of our team's execution in a dynamic environment. We are finding new ways to innovate for customers and improve our operational performance. In addition to our strong day-to-day execution, we are investing to capitalize on favorable market trends and serve emerging customer needs. I want to share a few impactful examples. In Health Care, our innovative Prevena therapy Incision Management System is the first and only medical device indicated by the U.S. FDA to help reduce surgical site infections in high-risk patients, helping lower the costly financial burden of complications, delivering on both improved clinical outcomes and cost savings for the health care system. In automotive electrification, we are building on 3M's long history in consumer electronics and now expanding our solutions for the future of transportation, including new display technologies for both electric and internal combustion engines, helping us drive above-market growth in our automotive business. In home improvement, we are building out a suite of innovations to help consumers personalize their homes, including our fast-growing line of Command damage-free hanging solutions, a $500 million franchise that leverages our world-class adhesive platform with even greater opportunities ahead. We have increased opportunities across our businesses to apply 3M science and drive long-term growth, and we will continue to invest and win in those areas. As you all have seen, the ongoing impact of COVID-19 is highly variable across geographies. Since the onset of the pandemic, we have increased our annual respirator production fourfold to $2.5 billion by activating idle surge capacity and building additional lines, while shifting 90% of distribution into health care to protect nurses, doctors and first responders. One of our strengths is to quickly adapt to changing marketplace needs. Global demand reached its peak in Q1 of this year, which included stockpiling from governments and hospitals. We are now seeing a deceleration in overall health care demand, and we are adjusting production, increasing supply to industrial and consumer channels while continuing to prioritize health care workers in the geographies seeing increased COVID-19 cases and elevated hospitalization rates. As we do this, we are reducing overall output to meet end-market trends. Like we have in the past, we are prepared to rapidly increase production in response to COVID-19-related needs or future emergencies when needed. As I reflect on the first half, I am pleased with our performance. We delivered strong sales and margin growth, along with good cash flow while building for the future and advancing sustainability with significant new carbon, water and plastic commitments. In the second half, in addition to investing in growth, productivity and sustainability, we also must navigate ongoing COVID-19 impacts and continue taking actions to address inflationary pressures and supply chain challenges. We will do this by driving an unrelenting focus on operational performance, which includes improving service, quality, operating costs and cash generation. I would like to thank 3Mers for your commitment and resilience as we bring together people, ideas and science to help transform businesses, solve customer challenges, and improve lives around the world. That wraps up my opening comments, and I'll turn it over to Monish to cover more details on the quarter and our updated guidance.

Thank you, Mike, and I wish you all a very good morning. Please turn to Slide 6. Company-wide, second quarter sales were $8.9 billion, up 25% year-on-year or an increase of 21% on an organic basis. Sales growth, combined with operating rigor and disciplined cost management, drove adjusted operating income of $2 billion, up 40%, with adjusted operating margins of 22%, up 240 basis points year-on-year. Second quarter GAAP and adjusted earnings per share were $2.59, up 44% compared to last year's adjusted results. On this slide, you can see the components that impacted both operating margins and earnings per share as compared to Q2 last year. A strong year-on-year organic volume growth, along with ongoing productivity, restructuring efforts and other items, added 4.1 percentage points to operating margins and $0.89 to earnings per share year-on-year. Included in this margin and earnings benefit were a few items of note. First, during the quarter, the Brazilian Supreme Court issued a ruling that clarified the calculation of Brazil's federal sales-based social tax, essentially lowering the social tax that 3M should have paid in prior years. This favorable ruling added $91 million to operating income or 1 percentage points to operating margins and $0.12 to earnings per share. Next, as you will see later today in our 10-Q, we increased our other environmental liability by nearly $60 million and our respiratory liabilities by approximately $20 million as part of our regular review. In addition, we also incurred a year-on-year increase in ongoing legal defense costs. We are currently scheduled to begin a PFAS-related trial in Michigan in October, along with the next step in the Combat Arms Earplug multidistrict litigation, with one trial in September and one in October. And finally, during the second quarter, we incurred a pretax restructuring charge of approximately $40 million as part of the program we announced in Q4 of last year. Second quarter net selling price and raw materials performance reduced both operating margins and earnings per share by 140 basis points and $0.17, respectively. This headwind was larger than forecasted as we experienced broad-based cost increases for chemicals, resins, outsourced manufacturing and logistics as the quarter progressed. As a result of these increasing cost trends, we now forecast a full year raw materials and logistics cost headwind in the range of $0.65 to $0.80 per share versus a prior expectation of $0.30 to $0.50. As we have discussed, we have been and are taking multiple actions including increasing selling prices to address these cost headwinds. As a result, we expect continued improvement in our selling price performance in the second half of the year. However, given the pace of cost increases, we currently expect a third quarter net selling price and raw materials headwind to margins in the range of 50 to 100 basis points, which we anticipate will turn to a net benefit in the fourth quarter as our selling price and other actions start catching up to the increased costs. Moving to divestiture impacts. The lost income from the sale of drug delivery in May of last year was a headwind of 10 basis points to operating margins and $0.02 to earnings per share. Foreign currency, net of hedging impacts, reduced margins 20 basis points while benefiting earnings by $0.08 per share. Finally, 3 non-operating items combined had a net neutral impact to earnings per share year-on-year. This result included a $0.06 earnings benefit from lower other expenses, that was offset by higher tax rate and diluted share count, which were each a headwind of $0.03 per share versus last year. Please turn to Slide 7 for a discussion of our cash flow and balance sheet. We delivered another quarter of robust free cash flow with second quarter adjusted free cash flow of $1.6 billion, up 2% year-on-year, along with conversion of 103%. Our year-on-year free cash flow performance was driven by strong double-digit growth in sales and income, which was mostly offset by a timing of an income tax payment of approximately $400 million in last year's Q3, which is traditionally paid in Q2. Through the first half of the year, we increased adjusted free cash flow to $3 billion versus $2.5 billion last year. Second quarter capital expenditures were $394 million and approximately $700 million year-to-date. For the full year, we are currently tracking to the low end of our expected CapEx range of $1.8 billion to $2 billion, given vendor constraints and the pace of capital projects. During the quarter, we returned $1.4 billion to shareholders through the combination of cash dividends of $858 million and share repurchases of $503 million. Year-to-date, we have returned $2.5 billion to shareholders in the form of dividends and share repurchases. Our strong cash flow generation and disciplined capital allocation enabled us to continue to strengthen our capital structure. We ended the quarter with $12.7 billion in net debt, a reduction of $3.5 billion since the end of Q2 last year. As a result, our net debt-to-EBITDA ratio has declined from 1.9 a year ago to 1.3 at the end of Q2. Our net debt position, along with our strong cash flow generation capability, continues to provide us financial flexibility to invest in our business, pursue strategic opportunities and return cash to shareholders while maintaining a strong capital structure. Please turn to Slide 8, where I will summarize the business group performance for Q2. I will start with our Safety and Industrial business, which posted organic growth of 18% year-on-year in the second quarter, driven by improving industrial manufacturing activity and prior pandemic impacts. First, starting with our personal safety business, we posted double-digit organic growth in our head, face, gearing and fall protection solutions as demand in general industrial and construction end markets remains strong. However, this growth was more than offset by a decline in our overall respiratory portfolio due to last year's strong COVID-related demand resulting in an organic sales decline of low single-digits for our personal safety business. Within our respiratory portfolio, second quarter disposable respirator sales increased 3% year-on-year but declined 11% sequentially as COVID-related hospitalizations declined. Looking ahead, we anticipate continued deceleration in disposable respirator demand through the balance of this year and into 2022. Turning to the rest of Safety and Industrial. Organic growth was broad-based, led by double-digit increases in automotive aftermarket, roofing granules, abrasives, adhesives and tapes and electrical markets. Safety and Industrial's second quarter operating income was $718 million, up 15% versus last year. Operating margins were 22.1%, down 130 basis points year-on-year as leverage on sales growth was more than offset by increases in raw materials, logistics and ongoing legal costs. Moving to Transportation and Electronics, which grew 24% organically despite sustained challenges from semiconductor supply chain constraints. Organic growth was led by our auto OEM business, up 76% year-on-year compared to a 49% increase in global car and light truck builds. This outperformance was due to several factors. First, the regional mix of year-on-year growth in car and light truck builds were in regions where we have high dollar content per vehicle. Second, a year-on-year increase in sell-in of 3M products versus the change in build rate. Lastly, we continue to apply 3M innovation to vehicles, gaining penetration onto new platforms. Our electronics-related business was up double digits organically, with continued strength in semiconductor, factory automation and data centers, along with consumer electronic devices, namely tablets and TVs. Looking ahead, we continue to monitor the global semiconductor supply chain and its potential impact on the electronics and automotive industries. Turning to the rest of Transportation and Electronics. Advanced materials, commercial solutions and transportation safety each grew double digits year-on-year. Second quarter operating income was $546 million, up over 50% year-on-year. Operating margins were 22%, up 340 basis points year-on-year driven by strong leverage on sales growth, which was partially offset by increases in raw materials and logistic costs. Turning to our Health Care business, which delivered second quarter organic sales growth of 23%. Organic growth was driven by continued year-on-year and sequential improvements in health care elective procedure volumes as COVID-related hospitalizations decline. Our medical solutions business grew mid-teens organically or up approximately 20%, excluding the decline in disposable respirator demand. I am pleased with the performance of Acelity, which grew nearly 20% organically in the quarter as it helps us build on our leadership in advanced wound care. Sales in our oral care business more than doubled from a year ago as patient visits have nearly returned to pre-COVID levels. The separation and purification business increased 10% year-on-year due to ongoing demand for biopharma filtration solutions for COVID-related vaccine and therapeutics, along with improving demand for water filtration solutions. Health Information Systems grew high single digits, driven by strong growth in clinician solutions. And finally, food safety increased double digits organically as food safety activity returns, along with continued strong growth from new product introduction. Health Care's second quarter operating income was $576 million, up over 90% year-on-year. Operating margins were 25.3%, up 880 basis points. Second quarter margins were driven by leverage on sales growth, which was partially offset by increasing raw materials and logistics costs, along with increased investments in growth. Lastly, second quarter organic growth for our Consumer business was 18% year-on-year with strong sell-in and sell-out trends across most retail channels. Our home improvement business continues to perform well, up high teens organically on top of a strong comparison from a year ago. This business continued to experience strong demand in many of our category-leading franchises, particularly Command, Filtrete and Meguiar's. Stationery and office grew strong double-digits organically in Q2 as this business laps last year's cohort related comparisons. We continue to see strength in consumer demand for Scotch branded packaging and shipping products, along with improved sell-in trends in Post-it Solutions and Scotch branded home and office tapes as retailers prepare for back-to-school and return to work. Our Home Care business was up low single digits organically versus last year's strong COVID-driven comparison. And finally, our Consumer Health and Safety business was up double-digits as we lap COVID-related impacts from a year ago, along with improved supply of safety products for our retail customers. Consumer's operating income was $311 million, up 12% year-on-year. Operating margins were 21%, down 160 basis points as increased costs for raw materials, logistics and outsourced hard goods manufacturing, along with investments in advertising and merchandising more than offset leverage from sales growth. Please turn to Slide 9 for a discussion of our full year 2021 guidance. While uncertainty remains, we expect global economic and end market growth to remain strong. However, it continues to be fluid as the world wrestles with ongoing COVID-related impacts that we all see and monitor. Therefore, there are a number of items that will need to be navigated as we go through the second half of the year. For example, we anticipate continued sequential improvement in health care elective procedure volumes. Also, we expect ongoing strength in the home improvement market and currently anticipate students returning to classrooms and more people returning to the workplace. Next, we remain focused on driving innovation and penetration with our global auto OEM and electronics customers. These two end markets continue to converge as highlighted by the well-known constraints in semiconductor chip supply. This limited chip supply is expected to reduce year-on-year automotive and electronics production volumes in the second half. As mentioned earlier, we expect demand for disposable respirators to wane and negatively impact second half revenues by approximately $100 million to $300 million year-on-year. Turning to raw materials and logistics. As noted, we anticipate a year-on-year earnings headwind of $0.65 to $0.80 per share for the full year or $0.40 to $0.55 in the second half due to rising cost pressures. We are taking a number of actions, including broad-based selling price increases to help mitigate this headwind. And finally, the restructuring program we announced last December remains on track. As part of this program, we expect to incur a pretax charge in the range of $60 million to $110 million in the second half of this year. Thus, taking into account our first half performance, along with these factors, we are raising our full year guidance for both organic growth and earnings per share. Organic growth is estimated to be 6% to 9%, up from the previous range of 3% to 6%. We now anticipate earnings of $9.70 to $10.10 per share against a prior range of $9.20 to $9.70. Also, as you can see, we now expect free cash flow conversion in the range of 90% to 100% versus a prior range of 95% to 105%. This adjustment is primarily due to ongoing challenges in global supply chains, raw materials and logistics, which are expected to persist for some time. Turning to the third quarter, let me highlight a few items of note. First, we currently anticipate continued improvement in health care elective procedure volumes across most parts of the world. Global smartphone shipments are expected to be down high single digits year-on-year, while global car and light truck builds, we expect to be down 3% year-on-year. Relative to disposable respirators, we anticipate a year-on-year reduction in sales of $50 million to $100 million due to continued decline in global demand. As mentioned earlier, we are anticipating a third quarter year-on-year operating margin headwind of 50 basis points to 100 basis points from selling prices, net of higher raw materials and logistic costs. On the restructuring front, which I previously discussed, we expect a Q3 pretax charge in the range of $50 million to $75 million as a part of this program. And finally, we expect higher investments in growth productivity and sustainability in the quarter, along with higher legal defense costs as proceedings progress. To wrap up, our team has delivered a strong first half performance, including broad-based growth, good operational execution, robust cash flows and an enhanced capital structure. With that being said, there's always more we can do and will do. We continue to prioritize capital to our greatest opportunities for growth, productivity and sustainability, while remaining focused on delivering for our customers, improving operating rigor and enhancing daily management. I want to thank our customers and vendors for their ongoing loyalty and partnership and especially our employees for their dedication, perseverance and execution in these uncertain times. With that, I thank you for your attention, and we will now take your questions.

Good morning, Mike and Monish. I'm looking at the price data on Slide 13 in the appendix. According to my notes, prices increased by about 70 basis points last quarter and appear to have risen by around 10 basis points this quarter. However, the significant challenge is in the Asia Pacific region. Could you provide some insight into what's affecting the price dynamics? I suspect there may be some mix or comparison issues at play. I'll leave it at that.

Yes. Sure, Scott. It's a great question. And you're right. But as I first said, we are raising prices everywhere. It's taking a little bit of time, but it's broad-based. You've seen what we have said we'll do in the third quarter and the fourth quarter. To answer your question specifically on the second quarter, you hit on one point, which is a comp issue from year-over-year but the second piece of this was also as the volumes came in pretty strong in the second quarter, we had some rebates that get accounted for with that extra volume, and that drove it. But when you reflect on the guide that we gave you, price pretty much came in where we thought. It's just slightly lower than that. So we were expecting this.

Okay. And then was there a supply chain impact on sales, an explicit supply chain impact on sales that held back sales? Or was it more just a cost logistics issue?

I would say, Scott, it's really hard to figure out exactly what the impact was. There definitely was an impact, I would say, in general, in the larger market and 3M was no different where supply constraints were there. The team has done a marvelous job of trying to keep the factories running the best they can and making sure we are taking care of our customers as quickly as we can. So I would say there were more inefficiencies that we have had to deal with just as raw material was not as fluid as we would have thought through this process. But overall, we have done our best to keep our customers whole through this process. But this is an ongoing piece, Scott, that we'll have to watch how the second half plays itself out. You're seeing not only us but end markets also getting impacted by some of the raw material shortages, and we're just going to keep working this as we go through the second half.

Can you guys talk a little bit about the durability in the Health Care margins? Impressive back to 25% this quarter, I'm just wondering if this is now kind of like a baseline going forward. We're back to kind of like the 2019-ish type levels.

Yes, Joe, that's an excellent question. We continually assess that situation. I'll start by noting that the team has done a great job increasing margins while still investing in the business. The significant year-over-year rise is largely due to the volume increase from Q2 last year compared to Q2 this year. Additionally, the volume leverage has contributed positively, but we have still faced challenges from raw material and logistics costs, and we are committed to investing in the business. To address your specific question about the future, it ultimately hinges on where the volume lands. As I mentioned earlier, there is a slowdown in disposable respirators, which is expected to impact Q3 by $50 million to $100 million year-over-year and $100 million to $300 million in the second half, primarily affecting the Health Care segment. We'll see how the volume evolves. Furthermore, our investments will depend on the trends in hospitalizations and elective procedures. Overall, we believe in continuous improvement, so we will keep focusing on productivity, reducing costs, investing in strategic areas, and enhancing efficiency in SG&A as much as possible.

Maybe just following up on that, it is helpful to have that context. As I think about just the Health Care business, right, you did mention that elective procedures have increased and perhaps maybe that's going to offset some of the respirator issue. Should we think of that as being mix-accretive? If, in fact, elective procedures are increasing and are potentially offsetting the weakness in respirators?

I would tell you, I think the way we got to think about it is, as electives go up, we don't have a one-for-one perfect connection between electives. So it depends on which piece of the demand goes up, Joe. So it's really hard to give you the perfect answer on whether it's mix or not. What I generally believe is as elective procedures go up and as volume picks up, you will see us getting more leverage because of that. How much the disposable respirator volume goes down and where it comes from will also have an impact. So it's a hard one for me to quantify exactly.

I would like to highlight that Slide 9 is particularly useful with all the details about your projections for the year and the third quarter. I appreciate the specifics provided. My first question pertains to capital allocation. Your balance sheet is in a solid position with a net leverage of 1.3 times. You have resumed buybacks; however, the share count seems to have increased. Why aren't you conducting more buybacks at this time? Can we start our discussion there?

Yes. Sure, Deane. As I told you, from our priority of capital allocation, our first priority is always investing organically between R&D and CapEx because we think that's the biggest return for our money. The second is dividend. You've seen we have increased dividend. It's the 63rd year in a row that the dividend is up. It matters to our shareholders. That's our second priority. Our third priority is M&A, and we will normally do M&A in the area where we believe that the target that we're going to acquire can benefit from being a part of 3M. Right now, we are busy integrating Acelity, and the team is doing a nice job integrating that. So we don't see any acquisitions of the size of Acelity in the near future, but we have an active pipeline of a number of things. And then our last discretionary use of capital allocation is share buybacks. So for the year, year-to-date, we have done $700 million, give or take. And I would say share buyback and continued share back depend on what the volume is going to be, depends on the needs of future capital in uses that we have as well as what the cash flow that we generate will depend on that. So I would say, we'll keep you posted during these quarterly calls as we continue this program and decide how much we do.

Terrific. And then just as a follow-up, given all the changes, it seems like day-to-day in the macro, any commentary about how July has started, especially regionally would be helpful here?

Yes, I believe the team is poised to continue performing well as we enter the second half of the year. We've discussed various dynamics, and Monish highlighted several trends we've observed. So far, there have been no surprises in the early weeks of July. We anticipate that global macroeconomic conditions and demand in the end markets will remain strong, although the situation will be dynamic. We are seeing a continued increase in elective procedures in healthcare and sustained strength in home improvement. The industrial sector as a whole is showing improvement as we move into the second half of the year. During the first half, we experienced broad-based growth across different regions, and we expect this trend to persist. However, there is uncertainty surrounding COVID and its potential impact on increases in cases and hospitalizations, with some areas experiencing this challenge. Although we are observing a decline in global demand for disposable respirators, some regions are seeing an increase in supply. This could influence the second half of the year across different parts of the world. While we expect overall pandemic-related respirator demand to decrease, we anticipate stronger demand in certain areas as the COVID situation evolves. This information provides some insight into our expectations for the second half of the year on a global scale.

Maybe just for the first one, a clarification. I wanted to know if you could give us an order of magnitude of what you're looking at in terms of price increases that you plan to put through across the product portfolio and obviously, understand it will probably vary by product line. And then second question is, if I look at your kind of organic growth, kind of the same growth-on-growth in Q2 as Q1. Was curious if you have any commentary around customer channel inventory? And if you're seeing any change in behavior there?

Yes, John, I would say that our teams are focused on implementing price increases in the second half to help offset inflation. This strategy is fairly broad-based. As we've discussed, it takes time to implement these price changes and keep pace with inflation, which has been an ongoing challenge throughout the year. We're expecting to see a stronger positive impact from these price increases as we move into the second half and approach the fourth quarter. We're continuously assessing our channel inventories around the world, especially given the dynamics in the marketplace and the various market conditions. It's challenging to determine the right inventory levels at this time. We have visibility on our sell-in and sell-out metrics, but the snapback in demand makes it harder to gauge appropriate inventory levels. There are some clear visibility issues, such as the ongoing semiconductor chip shortages affecting production volumes, which we can see reflected in our channel inventory. We've detailed our visibility on N95 respirators, but ultimately, how demand unfolds in each market will dictate our view of channel inventory as we progress through the third quarter.

I just wanted to try and circle back to the Safety and Industrial outlook. I suppose it's possible if we look at Q4 that your sales in that segment could be down year-on-year in aggregate because of respirators. Just wondered any perspectives on that? And also, the margin implication in 2020, your S&I margins were up a good amount. Q2, they're softer, I think, sequentially and year-on-year as the respirator business rolls over. So should we expect that sort of mix headwind to play out for a few more quarters?

Yes, Julian, that's an excellent question regarding Safety and Industrial. To address your specific inquiry about the impact, there is a possibility of a year-over-year decline. As a reminder, in 2019, we had approximately $600 million in revenue from disposable respirators, which increased to $1.4 billion in 2020. Looking ahead to the second half of the year, we indicated a potential risk of a revenue decrease between $100 million and $300 million from disposable respirators. If we reach the upper end of that range, which is $300 million, then negative volume is a definite possibility. As the demand for healthcare products has decreased due to fewer COVID-related hospitalizations and increased elective procedures, we have been shifting production from hospitals to other sectors, such as industrial and government. Additionally, we've seen growth in several other areas within Safety and Industrial, including our respiratory and safety portfolios, head and face masks, abrasives, adhesives, and roofing granules, as well as the automotive aftermarket. Depending on economic conditions and the level of industrial activity, we expect continued growth in these segments, and we believe those markets will recover in the long term. However, the situation will likely remain fluid in the second half as the COVID situation evolves. Regarding your second question on margins, you are correct; we benefited significantly from volume leverage in 2019 compared to 2020. Ultimately, the volume in the second half will influence our margins. We are actively pursuing price increases across that segment, but we need to consider how much of this is offset by costs related to raw materials and logistics. Additionally, we need to account for ongoing legal fees or reserves. Finally, our focus will also be on investing in growth, productivity, and sustainability, particularly as industrial activity rises in 2022 and 2023. All these factors combined will determine the direction of our margins.

Can you discuss, apart from the mask headwind, whether you expect other issues, like automotive challenges, to worsen sequentially as we consider the trends for the third and fourth quarters?

So Steve, I'd like to contextualize everything regarding the end markets, which we believe will remain strong overall. However, we expect some volatility as we move through the second half, particularly due to COVID developments. A few points to consider: we anticipate that elective procedures will keep increasing each quarter, although some regions may experience declines. Additionally, the automotive sector is showing growth, but it still faces a year-over-year decrease of 3% in the third quarter, with projections suggesting a decline of 3.7% in the fourth quarter. The semiconductor shortages are likely to affect this situation, and we'll need to observe how it unfolds. Smartphone shipments are expected to decline year-over-year, and we'll monitor the sequential results. Regarding tablets and TVs, which saw significant gains last year, they are also projected to be lower year-over-year, though it's difficult to specify the sequential impact. We've noticed a strong increase in stationery and office supplies in the second quarter, and that trend persists as retailers prepare for more employees to return to offices and children to return to school. However, the pandemic's trajectory may influence this. In the Safety and Industrial segment, as I mentioned previously, we assume that industrial activity will continue, but global supply chain shortages add considerable uncertainty to demand. Therefore, when considering all these factors, we decided to adjust our projection for the year to 6% to 9%, up from the earlier estimate of 3% to 6%. Overall, I... go ahead.

Yes. So on the raw mats, Monish, based on your FICO convention and food purchasing, et cetera, when do you expect commodity inflation to peak? I don't know whether that's on a year-over-year basis or whether that's on a sequential basis, but when do you expect to see the peak in those raw mats?

If you're specifically asking about commodities, it's difficult to predict. Initially, we guided $0.30 to $0.50, which has now been adjusted to $0.65 to $0.80. We've observed a broad-based increase in all commodities, including polypropylene and chemical resins found in our outsourced manufacturing goods. It's not just labor costs, but other commodities are being passed on as well. Logistics costs have been a significant challenge. I believe that at some point, demand and supply will need to stabilize. There's a high demand but insufficient supply due to the recovery and port congestion. Until this stabilizes, inflation will likely continue. Crude prices have risen more than expected this year, and polypropylene remains strong and inflationary. Ocean rates have also increased substantially in the last three to six months, making it challenging to predict when we will see a peak or a decline. We've considered all the factors we can and predicted inflation at $0.65 to $0.80. To counteract this, we are implementing broad price increases and working with suppliers to reduce costs. In the third quarter, we anticipate a headwind of 50 to 100 basis points in price versus raw materials. By the fourth quarter, we expect to be flat or positive, meaning that prices will offset the raw material inflation.

Okay. That's really helpful explanation. I think I'll stick with you here on the second half outlook. You're calling out legal costs, legal defense costs in the second half of the year. You didn't give a number around that. So I'm assuming it's not that material, but how do you think about just the magnitude of that in the back half? I'm just concerned if defense costs are not settlements necessarily. I'm thinking here about the earplug litigation and also Hoosick Falls settlement that you just announced?

Yes. The Hoosick Falls settlement was included in our reserve calculations. Ongoing litigation continues, and all relevant SEC filings, including our upcoming quarterly report, will provide updates on these cases. We have a PFAS case scheduled for October this year with Wolverine, as well as two Combat Arm trials on the horizon. As we prepare for these cases, our legal fees are increasing. We will allocate whatever funds are necessary to defend ourselves in these matters, and that is the reason for the incurred costs.

Just a sort of longer-term question. I think, historically, 3M has a very strong position in terms of sort of global capacity in your key technologies. How do you think about sort of global nonwoven capacity post COVID? And are you seeing emergence of new players? Does it change sort of strategic landscape for 3M vis-à-vis players, particularly players out of Asia longer term?

Thanks, Andrew. As I mentioned in my prepared remarks, we experienced a peak in demand, at least in the short term, in the first quarter. Throughout 2020, we increased our capacity, and by the end of the year, we were operating at an annual run rate of 2.5 billion N95 respirators. That's the capacity we started the year with. Other manufacturers also expanded their capacity in response to the pandemic, and we've observed some of them slowing down their operations as demand declines from the peak. We will also start to reduce our production lines in order to prepare for the next emergency or changes in COVID-19. We can ramp up production quickly. Our strategy is to maintain a leadership position in personal safety and protective equipment during normal times, focusing on industrial, consumer, and healthcare markets. We also have idle capacity that will allow us to respond rapidly in emergencies. Globally, we are now better positioned than ever to respond to a pandemic. It’s encouraging to see governments fulfilling their commitments to stockpile supplies, and we are actively supporting various initiatives worldwide as we move through the first half of the year. This prepares us better for future emergencies and pandemics. Regarding respiratory demand, we expect it to be higher than pre-pandemic levels as global usage and protocols evolve. Our brand remains strong, and we are well-positioned to leverage our leadership in PPE globally. We have a model that is well aligned, with available surge capacity for any future emergencies, and we are ready to fulfill our role in that scenario.

I guess my question was sort of broader and longer term. A lot of this technology is used in air filters, automotive, and I was just wondering if you expect this incremental capacity that was brought on by your competitors to go into these industrial adjacencies and generate just more global competition. That was the question actually.

Yes, I can talk about our nonwoven capacity. We leverage and utilize that in various areas, including air filtration. This creates an opportunity for us to benefit from the capacity we've built in response to the pandemic. We can also find innovative uses for our technologies in air filtration. I expect others will explore similar opportunities in various markets globally. However, I can't provide a specific estimate on how much capacity will shift. The world is expected to continue growing, especially with trends in personal safety and air filtration, leading to sustained demand. As we move forward, capacity will likely align with that growing demand over time.

So you always give kind of helpful color by geography, and there's been a lot of noise about things kind of falling down in China with respect to a lot of different pieces of macro data. Can you guys just talk a little bit about what you're seeing in China across your businesses?

Sure, Nicole. As I mentioned for the broader business, we experienced broad-based growth, with double-digit increases in our Transportation and Electronics, Safety and Industrial, and Health Care sectors. Consumer growth was in the mid-single digits as we progressed through the quarter. Our growth was primarily driven by general industrial sectors, particularly in our abrasives portfolio. The automotive and OEM sectors displayed strong growth, and electronics remain a significant market for us, representing 10% of our total revenue, with over 20% growth in the first half compared to 3% growth in the second quarter of last year. China rebounded earlier than other regions worldwide. Looking at the second half, comparisons may become more challenging, leading us to anticipate some difficulties year-over-year. Nevertheless, we believe there are still growth opportunities across our businesses in the same global areas we have previously identified. The automotive sector will remain a key focus as we seek to penetrate OEMs. Although our consumer business is our smallest segment, we see substantial potential to serve Chinese consumers, particularly in air and water quality. Thus, while we expect a more challenging year-over-year comparison, there are still opportunities for growth.

Got it. Thanks, Mike. And if I could just follow-up on the second half margin outlook. There's clearly a lot of moving pieces here with legal costs, growth investments, price cost. Maybe just to boil it down, do you guys still expect to kind of be in that 30% to 40% incremental margin range in 3Q and 4Q?

I would say that volume is the key factor that provides us leverage. That's the first step, especially considering the current volatility and uncertainty. The question is where our volumes will land in the second half, and we've indicated that disposable respirator sales are expected to decline by $100 million to $300 million year-over-year. Our team is focused on maintaining operational excellence to enhance productivity and efficiency throughout the supply chain. We are pursuing price increases, and we anticipate that by the fourth quarter, we will be able to counter the impacts of rising raw and logistics costs. In summary, the margins in the second half will depend on volume and our ability to mitigate raw and logistics cost pressures through price adjustments, ongoing productivity improvements, and effective execution by the 3M team. Additionally, our choices regarding investment in growth, productivity, and sustainability, along with the resurgence of indirect expenses as travel resumes, will play a role. We've been careful in the first half to avoid overspending in anticipation of a volume recovery, but as we see volumes pick up, those indirect costs will rise as well. Finally, we will continue to manage legal fees while doing what we believe is necessary to protect ourselves as these legal matters progress. All these factors will ultimately influence our incremental outcomes.

This is Eitan Buchbinder on for Andy Kaplowitz. Priority growth platforms delivered 10% growth in Q1. Can you update on how the group performed in Q2 as well as your outlook for the faster-growing businesses in the back half of the year?

Yes, Eitan. The priority growth platforms also had strong growth. We talked about it in Q1, second quarter as well. So overall, they were up over 40% in second quarter. Now over $500 million in revenue as a group. And I highlighted a couple of other areas of our businesses that are seeing strong sequential growth and market dynamics that are attractive. So these priority growth platforms broadly are in attractive market spaces. Part of that priority investment in growth that we've been talking about even as we came through 2020, staying focused and aggressively investing in growth areas and PGPs, as we call them, the priority growth platforms, continue to be an important part and performing well.

That's helpful. The Electronics Business Group was up 13% year-over-year, but down sequentially about 4%. So could ongoing chip supply constraints lead the business to decline sequentially in Q3?

We observed some strength in the end markets. In the first half, we were overall up, still in the low teens for the business. It felt more like seasonality rather than a sequential trend. As we move into the second half, we should anticipate more challenging comparisons. We experienced strong growth not only in home improvement and other consumer areas but also in the cleaning supplies sector during the pandemic. That is another aspect to keep in mind.

To wrap up, our second quarter performance was strong, marked by broad-based growth, increased margins and robust cash flow. I'm confident in our ability to continue executing well as we navigate COVID-19 impacts. And we will stay focused on taking advantage of market trends and overcoming supply challenges while continuing to invest in growth, productivity and sustainability. Thank you for joining us.